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HMRC internal manual

General Insurance Manual

Reinsurance and other forms of risk transfer: types of reinsurance: non-proportional reinsurance

Non-proportional reinsurance may take two main forms: excess of loss and stop loss. It is usually arranged by treaty but can also be on a facultative basis (see GIM8020).

Excess of loss

As the term suggests, excess of loss is where the reinsurer agrees to indemnify the insurer for losses (claims) in excess of a specified amount. This may relate to

  • individual risks (facultative basis)
  • risks within particular account (for example that part of each claim on buildings insured against fire and property damage which exceeds £500,000), known as excess of loss per risk, or excess of loss per occurrence - see the example at GIM8070 
  • claims in aggregate arising from a particular occurrence (for example claims in excess of £5 million in respect of storm damage), known as catastrophe excess of loss.

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Catastrophe excess of loss

Catastrophe excess of loss reinsurance was developed after the San Francisco earthquake in 1906 to protect insurers against exceptional loss.

It is aimed at covering the aggregation of the insurer’s retention on many risks from related events. It may involve both a horizontal spread, in that several insurers are involved in paying the claims, and a vertical spread, in that the risk may be divided into several layers for reinsurance purposes when it is known as layered treaty reinsurance. In this case, cover is provided in slices at each layer. The deductible amount of the first layer will be the amount retained by the reinsured (cedant), and different layers will be accepted by different reinsurers. When a claim is made collections are made from reinsurers on the layers affected. Cover is said to inure to the benefit of the catastrophe reinsurer if the arrangement is such that other (typically, quota share) reinsurance reduces the sum on which the catastrophe reinsurer’s liability is calculated.

See the example at GIM8080.

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Stop loss reinsurance

Stop loss or loss ratio is a specialist form of reinsurance which is a variation of excess of loss. The reinsurer agrees to pay the cedant company’s losses for a specified period (incurred or paid, depending on the contract), to the extent that they exceed a specified amount or proportion, subject to a specified limit.

Outside Lloyd’s, where it is used to protect Names who would otherwise have unlimited liability, genuine stop loss reinsurance is not widely used, the calculation of premiums presenting considerable difficulty.

Companies have used it in the past to shore up inadequately capitalised subsidiaries, and in some cases there has been doubt as to whether an arrangement of this type is, as a matter of law, properly characterised as a reinsurance contract at all.

An example of stop loss reinsurance is at GIM8090.